FOMC preview: potential dovish tone despite strong GDP reading

The Federal Reserve (Fed) is back in focus this week, with its chairman Jerome Powell expected to retain the current interest rate standing that has been in place for three meetings now.

However, we are seeing a growing feeling that the Federal Open Market Committee (FOMC) could need to take on a more dovish stance despite the rise in gross domestic product (GDP) seen on Friday. The past year has seen a clear deterioration in prices, with inflation on the slide. The last inflation reading from the US may have not continued that trend, with it marking just the second monthly rise in year-on-year consumer price index (CPI) inflation in nine months. However, the overall trend remains downward, and today's depressed core personal consumption expenditures (PCE) price index reading highlights that fact. With US President Donald Trump pushing for lower energy prices, there is a feeling that we could see headline inflation once again dented if he gets his way. This trend of falling inflation points towards a more dovish stance from the Fed, with rate rises postponed until we see the price growth turn upwards in a more sustained manner.

Friday’s GDP data provides many with the other side to the story, with the welcome jump to 3.2% signalling the end of the slowdown that has raised fears over the past two quarters. However, not everything is as rosy as it seems, with the build-up in inventories in the face of a continued US-China trade war expected to be reversed as we move towards a final conclusion in talks. That means that the benefits of this first quarter (Q1) reading could well be short-lived and temporary in nature. The oversized role of net trade and inventories will certainly add to that feeling, with depressed consumer spending highlighting why the dollar failed to really reflect this improved number throughout the course of Friday’s session.

With the fading boost from Trump’s Q4 2017 tax cuts and expectations of further GDP weakness in Q2, there is plenty of reason to think the Fed remain some way off another rate rise. With that in mind, this week’s meeting is likely to be more about the tone and outlook from the FOMC rather than action itself.

Currently, the dollar index chart looks particularly interesting, with Friday’s spinning top candle pointing towards a possible turning point for the near term. The fall back below the 80 mark on the stochastic oscillator would add to that bearish sentiment. Such a move lower would likely be a retracement of the rally from either 96.21 or 95.15. A bearish outlook would be negated with a rise above the 97.84 peak, yet until that happens it makes sense to look for further downside as we move into this meeting.

In some ways, traders could see the developments over the past month as being a cause for a more hawkish Fed, with rising inflation and GDP boosting confidence in the economy. However, if we look at underlying factors, there is also a strong chance we could see the Fed look past that to see the potential for further weakness in the coming months. And that will be what is key in Wednesday’s meeting.